Why the dollar is down

Short answer, of course: I don't know. I'm not an economist, and even if I were, I probably still wouldn't know. But here goes anyway.

The United States, because of our free markets, low tariffs and stable government, has become the low-cost producer in the world. Consider automobiles: Honda, Toyota, and BMW, along with the Big Three, are going great guns. Likewise, airplanes, computers (beyond the cheapest), software, all kinds of services, etc., are cheaper in the USA than anyplace else. The very best place to go shopping is in the United States.

Other countries, e.g., China, for political reasons need to keep their currencies high relative to the dollar in order to remain competitive. For this reason, the dollar has historically been over priced on a purchasing power parity (PPP) measure. Further, to remain competitive, these countries have been forced to subsidize the American consumer and the American government, resulting in very low interest rates in the USA. As a result, Americans have not been saving - why bother when the rate of return barely covers inflation?

But the whole thing is unstable. At the end of the day, the high productivity of the American worker will out, and it is just a matter of time before there must be a correction. The subprime mortgage mess is just the catalyst to make this happen - the dollar has fallen to PPP, and perhaps even overshot a bit. Our trade deficit is improving, which is just another way of saying that other countries are buying from the low cost producer, namely us.

There is an alternative explanation, which is true for most countries that have a declining currency, and that is inflation. If the Federal Reserve were simply printing money (as, for example, in Zimbabwe), then the cause of our devaluation would be a ruined currency. The solution would be much higher interest rates and a reining in of excess money. But that is not the problem today. Despite a dramatic rise in the prices of oil and other commodities, the core rate of inflation in the US is not significantly higher than in the past. The Fed, I believe correctly, sees the subprime problem as one of too little liquidity, rather than too much, and thus they are gradually loosening money rather than tightening it. However, if I am wrong, then one will expect to see a dramatic increase in inflation over the next six months; but I don't think we will, as I don't believe that the dollar's fall is due to US Fed or fiscal policy.

Instead, the chickens have come home to roost for China and other developing countries, that have maintained their export markets by subsidizing the American consumer. But their own consumers have been hurt - why manufacture cars in China (or Europe) when you can buy them so much more cheaply from the United States?

Perversely, the dollar's decline is strong evidence for the strength of the American economy, the productivity of the American worker, and for the benefits of free trade, low taxes and limited government.

Milton Friedman was right before, and he is still right today.